Are complications of tax-deferred investing worth it?

[JGB]

After reading MMM's article "How Much Is TOO MUCH in your 401k?", I'm finding myself left with some decisions to make. From the basic calculations presented here, my wife and I have enough in our TSP/401k to fully fund our normal-age retirement, by the time we get there. So I am left looking at how best to save and invest between now and then. If all goes according to plan, I expect to be able to shift toward a 4-day week in a few years, and then to full retirement some 5 years after that (which would be around age 40). In all, I'll have some 7 to 10 years to invest between now and then, for an amount that will be expected to hold us over through the remaining ~20 years until our 401ks are available.

I am currently debating where to make these interim-year investments. Maxing our Roth IRAs every year is a no-brainer, but that amounts to a fairly small portion of our total yearly investments. I have narrowed down the remaining options to additional 401k investments (which will subsequently necessitate some of the accessibility strategies discussed in that article) or more standard investment accounts. The lure of the 401k is two-fold: first, we lower our tax burden now, and second, we avoid any kind of capital gains taxes. I do believe that my tax rate will be significantly higher in the interim working years, than in any of the retirement years, but I am not sure if that is enough to make the 401k into the best option.

Thoughts?

[DavidR]

In general, investing in a tax deferred account is the best strategy because the money is compounded on pre-tax dollars.  This results in a higher after tax return even if the tax rates are the same during the investment period and during the period when the funds are withdrawn.  Also, deferring a tax liability is normally the best strategy because historically marginal tax rates have had a downward trend (but this might not continue)

The offset (there is always an offset) to investing in a tax deferred account is liquidity.  If you need to use these funds you may have to pay tax on the withdrawal and may have to pay a penalty for a pre-mature withdrawal.  Therefore they should be used for retirement purposes. 

Also, notice that while you avoid capital gains taxes on the capital gains, you do not get the benefit of lower capital gains taxation when you withdraw the funds, as they are taxed at ordinary rates even if the money is the result of a long term caital gain.

[matchewed]

Yes it is worth it. Please see the the following posts. And it is not altogether that complex. Post 59.5 it gets treated as income. Pre 59.5 there are a couple of options to access it, also not terribly complex.

https://forum.mrmoneymustache.com/continue-the-blog-conversation/getting-rich-from-zero-to-hero-in-one-blog-post/

https://forum.mrmoneymustache.com/investor-alley/questions-about-how-to-best-allocate-my-savings-to-achieve-fi-asap/

https://forum.mrmoneymustache.com/ask-a-mustachian/tie-up-savings-in-401kira/

Is the tax savings worth it? Generally yes. I'm not certain about your current income or expenses but saving now to only pay income tax when you FIRE will generally be worth it, especially if your expenses are low. If you have high expenses, and plan on maintaining them in the future, you might have to just work out the current savings vs. future anticipated taxes to get an idea.

You also mention that it will be a significant difference. So avoid paying taxes on $17500 now when your marginal tax rate is what 25 or 28? And then pay only 15 on it later? Compound that over 5-10 years? Yeah I'll take the avoiding paying 25-28.

[velocistar237]

If the expected tax rate difference between your current tax rate and your retirement tax rate is at least 10%, then it's a no-brainer. Even if you took the penalty on the chin, you would come out ahead, and between 72t and Roth conversions, you can avoid the penalty. With the Roth conversions, you just need enough in non-retirement accounts to get you through 4-5 years. You can also use your Roth deposits up to this point to get you through those years. Go with Traditional instead of Roth for future investment unless you're above the income limit. Search the forum, this has been discussed several times.

[little_owl]

I felt a little like you did, that I was putting all this money away that I couldn't touch until I was 59, in my 401k.  But then, I realized (like the other replies here) that the money is (1) growing tax free and (2) reducing my overall tax bucket today -- so while I am annoyed that I will *hopefully* be retired for nearly 20 years before I can touch it, it is smart for me to build it up over time.

I did realize that, with true early retirement (40 or earlier in my book) that I needed MUCH more outside of my 401k - I found that through moving savings around and investing only in regular investments outside of my 401k - we were going to do a Roth, but since we aren't eligible to do a Roth with the tax benefits, after maxing out our 401ks, everything goes to regular investment funds to grow the 'stache that we can get at whenever / however we like.

Right now, our 401ks are bigger than our regular investment stache, which is annoying!  But, at least we'll get a nice gift at age 60!

[matchewed]

But one of the points missed is that you don't have to wait until you are 60. It is a common question on these boards and although the answer may change in the future currently it is best to understand all your options including those involved in accessing your funds prior to 59.5.